After a downturn in the volume of polymer industry mergers and acquisitions over the past several years, market forces and economic indicators are all pointing in one direction: consolidation is rapidly approaching. Current trends indicate that the latter half of 2004 will see a marked increase in the number of M&A's, especially involving financial buyers.
Will your firm pursue an aggressive growth strategy through acquisitions?
Will your company pursue a status quo strategy and not take part in the growing number of M&A deals? Will your company pursue a value-maximizing exit strategy and seek out a potential buyer? These are all important questions to consider.
For many polymer-related companies, recent years have been characterized by thinning profit margins despite efforts to slash costs and improve productivity. Increasing global competition has resulted in companies being squeezed on pricing by both suppliers and customers. At the same time, polymers remains one of the United State's largest and most fragmented industries. Furthermore, the private equity sector is holding unprecedented amounts of uninvested capital that must be put to use. Taken together, all these elements are working toward generating a sizable upswing in the volume of M&A's over the coming months. Therefore, it is vital to position your company to best exploit this unique market opportunity.
The polymer industry is uniquely positioned for strong M&A growth given its overall size and the vast number of smaller companies operating across a spectrum of sectors. The polymer industry is among the five largest industries in the United States. According to one study, annual sales eclipse $320 billion across over 20,000 companies that employ about 1.5 million. Noncaptive plastics processors account for about $134 billion of these sales. Despite the overall size of the industry, a majority of plastics companies post annual sales of less than $25 million. This bottom-heavy industry demographic stands in sharp contrast to other large industries — such as finance, communications and utilities — that are dominated by several large competitors and have relatively fewer smaller firms.
Outsourcing of polymer manufacturing to China and elsewhere will also drive M&A deals. Many observers believe that, in the long run, only those polymer companies producing high-value-added products will be able to maintain their manufacturing operations in the United States. Accordingly, all polymer companies manufacturing commodity and/or low-value-added products should consider either outsourcing their manufacturing operations to low-cost manufacturing areas or actively position themselves to be acquired, while they still have value.
The diversification of the polymer industry will also fuel more transactions. Given the scope of the industry, it presents an excellent opportunity for companies to extend product and market reach while reducing industry overcapacity. Also, consolidation allows for targeted geographic expansion and increased economies of scale. Additionally, as a company extends its market reach, it reduces the risks from industry cyclicality.
Increasing demand for M&A deals among strategic buyers should be a driver of industry consolidation. Strategic buyers currently account for roughly three-quarters of all acquisition activity, given that there are many distressed companies available. More-favorable financing terms that have recently become available to strategic buyers are going to further push transaction volume to very high levels.
Capital burning holes
in some deep pockets
Perhaps the greatest force that will drive an increase in M&A transactions is the large amount of capital that must be put to use. Private equity investors are sitting on well over $100 billion of uninvested funds, after record amounts of capital were raised throughout the 1990s. Investment periods for private equity funds are typically 10 years, meaning that fund managers are facing increasing pressure to generate returns on capital that is nearing the end of its investment cycle. This capital currently sits uninvested due to the market volatility of the past several years.
Given the recent upswing in the economy and financial markets, private equity funds are increasingly willing to consider new investments. These funds are also setting much lower goals for returns, all to the benefit of companies seeking fresh infusions of equity. Many fund managers are looking at projects with expected returns of around 25 percent, vs. previous years when deals were expected to generate returns upward of 40 percent.
The increase in deal activity is also spurring higher multiples for polymer companies. Valuation multiples being paid by private equity investors have recently ranged from 5-6.5 times pretax earnings. Some companies have received multiples as high as 8-8.5 times EBITDA. From the perspective of transaction size, transactions under $25 million have averaged multiples of 5.3 times EBITDA over the last 12 months. Transactions in the range of $25 million to $250 million have fetched over 7 times EBITDA. Multiples for deals valued at over $250 million have recently been about 9-10 times EBITDA.
Another recent trend has been the narrowing of the gap between multiples paid by financial and strategic buyers. Many financial buyers are pursuing platform company investments in high-growth sectors, achieving operating synergies and economies of scale previously only available to strategic buyers.
The recent availability of debt capital and the newfound tolerance among banking institutions for higher multiples of debt to EBITDA is allowing for more leveraged buyouts and leveraged recapitalizations. LBO valuations are also rising.
Middle-market M&A deals across all industries are already trending upward. Deals in the range of $100 million to $500 million grew at an estimated pace of 14 percent in 2003, while deals of less than $100 million lagged by posting only 4-8 percent growth. Projections for 2004, however, suggest that transactions in the range of $50 million to $100 million could experience a surge of 20 percent or more.
Things to consider
in sizing up a target
If your company is well-situated to pursue an aggressive strategy of growth through acquisitions, it is crucial to carefully consider your company's long-term goals in the context of any potential target. Aside from any operating synergies and econo-mies of scale you might hope to achieve, it may be important to think about how the respective corporate cultures may mesh or how vital customers may respond. When evaluating a potential target, contingent liabilities of the target should also be examined, as that may impact how the transaction is structured and the ultimate price that is paid.
Strategic buyers should also be aware of the growth prospects of the target and be prepared to pay a much higher valuation multiple for those industry sectors with the greatest forecasted future demand. For example, currently a buyer might pay a much lower valuation multiple for an automotive injection molder, given the serious overcapacity in that industry segment.
The buyer should also expect, however, to achieve slower future growth in demand than could be realized by acquiring a medical-device molder. The medical-device molder, in turn, is currently demanding much higher valuation multiples.
Or, how to become
an attractive target
Alternatively, to position your company as an attractive target and to maximize its value, be sure to pay close attention to several key areas. Even if you opt to sit on the sidelines as polymer industry consolidation increases in the coming months, attention to these core issues will serve your company well for years to come.
Focus on a strategy that promotes healthy future cash flows. Even as you may be pursuing an exit strategy, future growth prospects are critical to your company's value. A potential buyer is going to place much less emphasis on a company's current flat profit than on the cutting-edge research and development and capital investments the company has made, if those investments generate forecasts of strong growth in future cash flows.
Work to effectively manage your company's potential liabilities. Is your company facing the threat of significant litigation? Have all regulatory compliance concerns been fully addressed? Does your factory have any lurking environmental issues? The less risk your business poses to the buyer, the more reward you are likely to see.
A strong management team is essential. Especially for financial buyers, talented leadership is rewarded with higher valuations, as the management team cannot be imitated as easily as a product line or a distribution network. Having management actively involved in the deal can be extremely effective in smoothing the inevitable bumps in the road your employees and customers may experience during any transitional period.
Development of a strong customer base in critical. Think about who your company sells to and how much leverage you possess in those relationships. If you are a key supplier in a high-volume/high-margin contract that does not expire until many years into the future, your company will be much more attractive to potential buyers. Having a well-diversified assortment of customers is also important so that the loss of any single customer would not severely impact your company's bottom line.
Take steps to protect your propriety information. You have worked hard to develop the intellectual property, customer lists, sales strategies, instrumental technologies and pricing formulas that have made your business so successful. Make sure you receive full value for this crucial information in any M&A deal by seeking necessary patent, copyright and trademark protection, while also securing confidentiality agreements from key parties.
Given the current forecast and outlook for the polymer industry, it may be time for your company to pursue a growth strategy, or it may be time to pursue an exit strategy. No matter what path your company takes, it is essential to consider what implications industry consolidation may have on your business.
Lee M. Korland is an associate with Cleveland law firm Benesch, Friedlander, Coplan & Aronoff LLP.